Sunday, September 18, 2011

The impact of declining manufacturing in the US

Even as America is debating whether austerity or stimulus should take precedence, a quiet transformation has been taking place in the country's manufacturing sector. The Times reports,

"Manufacturing’s contribution to GDP... has declined to just 11.7 percent last year from as much as 28 percent in the 1950s, according to the Bureau of Economic Analysis... It isn’t that fewer autos or plastics or steel products or electronics are coming out of American factories. Quite the contrary: output continues to rise, reaching $1.95 trillion last year. But other sectors of the economy have grown faster in recent decades, and that dynamic has reduced manufacturing’s share.

In particular, the finance, insurance and real estate sectors — driven especially by investment banking and home sales — rose from less than 12 percent of GDP in the mid-1950s to more than 20 percent before the onset of the financial crisis, and even now remain nearly that high. In China, in sharp contrast, manufacturing’s share of national output is more than 25 percent. While the United States has a far larger economy — $14 trillion in GDP versus China’s $6 trillion — it has less factory production."

The graphic below nicely captures this story.

However, as the aftermath of the sub-prime crisis has shown, financial sector cannot be the basis for a nation's economic growth. It can at best support and lubricate economic growth, but cannot be a substitute for manufacturing. As the Times writes,

"Recovery from the recession, they say, would not be so sluggish if there were still enough manufacturers to jump-start an upturn by revving up production and rehiring en masse at the first signs of better times. What’s more, each new manufacturing job generates five others in the economy. Shrinking the relative size of manufacturing has undermined that multiplier effect."

The long-term consequences goes beyond this. The report writes,

"The intractable trade deficit is attributable in part to manufacturing’s shaken status. And in many areas, craftsmanship in America has been eroding. Forty percent of the nation’s engineers work in manufacturing, for example, and that profession’s numbers have been declining. That is a particular problem because innovation often originates in manufacturing, frequently in research centers near factories, which aid in the creation of products and the tweaking of them on assembly lines...

As American multinationals become ever more global, they are placing sophisticated research centers near their overseas factories, partly to keep R&D close to assembly lines and partly because of enticing government incentives... At the very least, this trend challenges the view that the United States has the best scientists and research centers and is thus the research-and-development pacesetter."